Airlines Accused of Gaming Tax Rules

By

Jack Nicas

Updated Jan. 14, 2013 8:43 p.m. ET

CHICAGO—The transportation authority here accused two of the world's largest airlines, United Continental Holdings Inc.UAL-0.79% and AMR Corp.'s American Airlines, of dodging a combined $300 million in local taxes since 2005, expanding its allegations that several towns in Illinois are illegally operating as tax havens.

The Regional Transportation Authority alleges United and American set up "sham offices" in Sycamore, Ill., population 17,500, in order to save tens of millions of dollars in annual sales tax on the fuel they purchase for their planes at O'Hare International Airport in Chicago.

The RTA says the carriers actually conduct their business in Chicago—though they route the transactions through Sycamore—and should be paying the higher taxes in Chicago, which has one of the biggest public pension shortfalls of any city in the U.S.

The RTA sued United on Monday in Cook County Circuit Court. The authority, which oversees the mass-transit system in the Chicago metropolitan area, declined to sue American Air because it is still in bankruptcy court.

"This is a tax-dodging scheme. It's not like the law allows this," said Jordan Matyas, chief of staff at the RTA. If United wants "the benefits of a headquarters in Chicago, it can't then choose a fake office in a small town and not pay the appropriate sales tax."

United called the suit "without merit" and said its "fuel subsidiary in Sycamore has been examined by tax authorities in the past and has been determined to comply with all applicable laws." American said that its fuel-purchasing operation in Illinois is permitted under state law.

Sycamore said it is confident in the legality of its United deal, which has lasted for more than 10 years and "has been examined by tax authorities…and determined to comply with state law."

The allegations are the latest in a series of legal disputes in Illinois and California, where big cities are accusing smaller towns of helping companies avoid paying the cities' sales taxes. Most of the disputes allege that the smaller towns lure the companies by agreeing to rebate much of their sales tax.

Four cities in California, including San Diego and Livermore, are challenging a sales-tax agreement between Fillmore, Calif., population 15,000, and Owens & Minor Inc.,OMI0.37% a medical-products distributor with more than $8 billion in annual revenue, said Troy Brown, Livermore's assistant city manager.

A challenge pending with the California Board of Equalization and a related lawsuit claim that Owens & Minor routes transactions through an office in Fillmore in order to pay sales tax there instead of to cities where the company maintains much larger operations, Mr. Brown said.

Owens & Minor said its "business operations in California are appropriate and consistent with the laws" there. It declined to comment further because of the pending litigation. Fillmore officials didn't respond to requests for comment.

The city of Chicago, surrounding Cook County and the RTA filed suit in county court in 2011 against the towns of Kankakee and Channahon—each roughly 50 miles south of Chicago—for allegedly luring more than 40 companies to route transactions through their towns by inking sales-tax agreements that rebated as much as 85% of the tax revenue to the companies. The companies include Target Corp.TGT-0.10%; computer maker Gateway Inc., a unit of Acer Inc.ACEIY0.00%; and Lands' End, a unit of Sears Holdings Corp.SHLD1.22%, Mr. Matyas said.

Mr. Matyas said other large public companies are included in the list, including other airlines, but they can't be disclosed because of a court order. A new Illinois law will mandate their disclosure later this year.

Target said it closed its Kankakee office in 2010 and declined to comment further. Sears declined to comment. Gateway couldn't immediately be reached for comment.

The mayors of Kankakee and Channahon dispute the allegations in the case, which is pending, saying their deals are within state law. "I can't compete with Chicago on some of incentive deals they can do. Why shouldn't I be able to use [Kankakee's] 6.25% [sales tax] rate to my advantage?" Kankakee Mayor Nina Epstein said. "It's not my fault that Cook County has a 9.75% rate."

Kankakee has agreements with about 45 companies that net it about $4 million a year, or one-sixth of its annual budget.

Two courts have recently sided with a town in a similar lawsuit. A county court and an appeals court have both ruled against the RTA, Cook County and the state of Illinois in their suit against tiny Mark, Ill., population 500, and a local oil company over their sales-tax agreement. The appeals court ruled that state law allows for companies to pay sales tax to the municipality in which they "accept" the purchase of goods. The state, county and RTA are appealing the decision to the Illinois Supreme Court.

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